Checklist for Buying or Selling a Small Business
Starting a business is relatively simple, especially if you have worked with a startup lawyer. Selling your small business, however, may be more challenging than you anticipated. This article highlights some of the guideposts in the merger or acquisition of a small business.
Forming a new business is not challenging. You can form a business just as quickly as you ask your small business lawyer to file the papers with the corporations department or in Washington DC with the Department of Consumer and Regulatory Affairs. As you have started your new small business, you have followed the checklist that Rosten Law prepared for starting your new business.
Related article: Checklist for Starting a Business
Selling a business is a lot more challenging than forming a business. There may be many reasons to exit and you now want to receive the full value (value is in the eye of the beholder of course) of the company that you started. You will need the services of your business advisers, your tax advisers and of course your mergers and acquisitions attorney.
Get ready for due diligence
You have been running your business for years and all of your information is strewn across many files and computers. Now is the time to impose some order. Get your tax returns out. Where are your major contracts? Make sure you have a copy of your insurance policies and signed copies of your leases. If you have employment contracts or licensing agreements, make sure that those are readily available in one folder. Most of these documents are shared electronically during the due diligence process so you should make sure that the documents for your business are in electronic form in a secure location.
Undoubtedly the most important information will be the financial statements so make sure that you clean them up and are ready to explain any discrepancies between your financial accounting and your tax accounting. You should develop a due diligence checklist and even before you do anything else, you should get started with compiling the information that you will need.
Retain the services of a business broker or investment banker
You may consider having the assistance of a business broker or an investment banker. If you have a larger business with values of at least $5 million, then you may want to seek out the services of an investment banker (iBanker). In some parts of the country, the iBanker is referred to as a M&A Advisor. An investment bank is regulated as a broker dealer and is a member of the Financial Industry Regulatory Authority. All investment bankers take an examination to make sure that they have a firm grounding in mergers and acquisitions and the securities industry. Investment banks charge a monthly retainer and a success fee. They are not inexpensive.
And on the other end of the spectrum, if your annual revenues are lower than $250,000, it may not be easy to find even a business broker who can assist you. Many business brokers focus in on valuations in the range of $1 million to $10 million. Usually business brokers have some industry expertise and experience representing companies of your size. You should interview prospective business brokers. You will find that their services differ widely and you should have a firm idea of what it is that they will be doing for you.
You will probably come across a dizzying array of acronyms or titles after the name of the broker that you are interested in. In many states, the business broker needs to hold a real estate license to be a business broker, although it is a little strange that a real estate license is related to brokering a sale of a business with sometimes no real estate involved.
You will find various assignations after a broker’s name. You are probably familiar with many of them such as MBA or CPA. You can find more detail about these designations in this article on Divestopedia. This is a brief summary of some of the designations that you may find as you are searching for a business broker.
• You know that a MBA is a master’s degree in business administration and the business broker is telling you that he or she graduated and earned a degree in business administration. You should certainly ask from which institution the business broker received the MBA.
• A CPA is a certified public accountant. The CPA has passed a rigorous exam on auditing and attestation, financial accounting and reporting, regulation and business environment and concepts (such as economics, finance, IT).
• The Chartered Financial Analyst (CFA) is someone who has 300 hours of preparation to pass an exam.
• A Certified Business Intermediary (CBI) is someone who has three years of experience in business brokerage or mergers and acquisitions, pass an examination and complete 68 class hours through the International Business Brokers Association (IBBA).
• The CM&AA is a designation from the Alliance of Merger & Acquisition Advisors to those who have completed a five-day training program on corporate finance, advisory and transaction service professionals.
• Those who trumpet their M&AMI means that they have at least 3-5 years of experience and 20-40 credit hours of M&A coursework.
Business brokers will generally offer you an agreement, which is usually an exclusive arrangement for some period of time. You should have your small business attorney review this agreement as there are provisions in these kinds of agreement that vary widely.
Some of the major points include compensation, do you have to close on the deal before the fee is due, how long of a tail is there on the backend of the contract, what happens when your business colleague decides that she wants to purchase your company during the term of the agreement. You should not let the business broker tell you that its standard agreement is “non-negotiable.” It isn’t and that may mean that in some cases you may have to find a different business broker.
Value your company
There are numerous ways to value your company. Once you have clean financial information, your business broker is going to put the financial information into its computer program and out will come an elaborate analysis of the value of your company. They may have a lot of experience in your industry and generally may provide good guidance but theirs should not be the final word. Financial information is often restated. What should go into the revenues or what should be taken out of expenses? There may be some non-recurring expenses that you will want to take out of the calculation. And what multiples are you going to use. A common approach to value small businesses is EBITDA, which is earnings before interest, tax, depreciation and amortization. During different business cycles, some small companies can command a multiple of five times EBITDA, but in recent times, in many industries the multiples are as low as two or three.
Your business broker, just like a real estate broker, usually doesn’t get paid unless the deal closes, so the business broker has an incentive to talk you into a lower value for your business. A professional broker should not unduly lowball the value of your business, but you should be aware that there is this danger.
Some folks may recommend that you retain the services of a valuation professional, who can provide an independent value for your company. The independent appraiser has no incentive other than to provide you with a realistic guideline for the value of your company. Some of these valuations can go awry and certainly if you have two different appraisers they may come up with different conclusions. Nevertheless, it may be worthwhile to have this independent bit of information.
Also, just like when you go to sell your home, you have the option of representing yourself. In smaller deals, you may have no choice as there are not many brokers who will represent businesses under $100,000, and even for a business with a valuation under a million dollars there are fewer brokers. Small companies are usually considered between $1 million and $20 million and there are many business brokers that specialize in these small businesses.
Remember that your business broker will likely be compensated based on the sales price. Your mergers and acquisition lawyer like Rosten Law is paid on the hours worked. What that means is that regardless of the value of the company, whether it is a $500,000 deal or a $5 million deal, the legal fees will roughly turn out the same.
Preparing a prospectus
Your business broker will prepare a prospectus based on the information that you provided. The prospectus will cover the industry in general and your company in particular. The most important sections of the prospectus from the point of view of the prospective buyer will be the personnel section and the financials. Are the key employees intending to stay if there is purchase? Does the company have them locked in in case the new owners are interested in maintaining them?
Don’t forget securities considerations
Your attorney should let you know if you need to be concerned about securities considerations. Under the federal securities law, if you are selling securities such as stock in your company then you need to be keenly aware of the requirements for complying with the federal and any state applicable securities laws. In its guide on Small Business and the SEC, the Securities and Exchange Commission succinctly provides this guidance: “If a small business is offering and selling securities, even if to just one person, the offer and sale of the securities must either be registered with the SEC or conducted in accordance with one of the many registration exemptions under the Securities Act.”
Get ready for kicking the tires: false allure of non-disclosure agreements
You will get people who simply are there to kick the tires or maybe collect sensitive information. On the one hand, you have to provide enough information usually without a non-disclosure agreement (NDA) to whet the appetite of the prospective buyer. Then your broker will generally get a non-disclosure agreement signed. Even with a NDA, you may not want to release all of your sensitive information. You should be very careful about releasing the most sensitive information, such as distributors or customer lists. You should hope that the broker has pre-qualified the buyer, but nevertheless even though you have an agreement, should the prospective buyer violate the agreement, you are looking at substantial attorneys’ fees to try to enforce a NDA. You should discuss with your lawyer and your broker what information you will release and when you will release the information.
Letter of intent
The prospective purchaser will prepare a letter of intent containing the major deal points. These LOIs are generally not enforceable understandings between the parties. I say non-enforceable because generally they are not but there are instances in which courts have ruled that poorly written LOIs may rise to the level of agreements, and although the purchaser thought it was not binding, the LOI was held to be an enforceable contract. And even by their terms, some LOIs have provisions such as confidentiality that are binding by their terms. If you have a LOI that you are considering accepting or if you are the purchaser and you have prepared a LOI, you need to consult with an attorney. It is advisable to prepare the LOI or review the LOI with all of the major terms with the assistance of an attorney.
Purchase and sale agreement
In another blog post, we will cover purchase and sale agreements in much more detail. There are numerous issues that are considered in the purchase and sale agreement. The major issue is whether the sale will be an asset sale, which is generally favorable and in most cases demanded by the purchaser, or a stock sale. There are instances in which a stock sale makes sense, but most smaller deals are structured as asset sales so that the purchaser is buying the assets of the company, not the liabilities. And from a tax perspective the purchaser wants to the stepped up basis in the assets of the company. How to structure the deal even after you have agreed on the value of the company with the purchaser is a major point of contention.
If you are the buyers, your mergers and acquisitions attorneys will generally prepare a due diligence questionnaire. The checklist will include detailed information and documents on the financial condition of the company. The buyer needs to decide whether the buyer is willing to accept unaudited statements as most very small businesses are not going to have audited financials. The financial information should include a detailed breakdown of all expenses, price policies, and inventory valuation.
The seller should provide information on all of the assets of the company, including intellectual property. The buyer will want to see all significant contracts such as bank lines of credit, acquisitions and development loans, leases, indemnity agreements, employment agreements and others. If the company is a government contractor, then the buyer will want to see any major contracts with the government or certainly any Multiple Award Schedules (MAS) and Federal Supply Schedules (FSS).
All material litigation, pending or even threatened, should be disclosed. The mergers and acquisitions lawyer for the buyer will usually run a litigation search, check for liens, conduct searches on the intellectual property and review bankruptcy records.
Usually the buyer will want a list of all employees or 1099 contractors and even those employees who left the company within a period of time or independent contractors who did any work for the company in the last 12 months. If the business has any federal or state licenses or permits, they are disclosed during the due diligence and if the business owns any property, any environmental issues must be disclosed. Tax and insurance and memberships in any trade organization are also listed in the due diligence process.
Closing for a small business
The closing ceremony used to be a relatively elaborate affair but now the mergers and acquisition lawyers usually have completed most of the documentation and exchanged final versions before the closing. In many closings, the parties may not even need to show up. Some small business owners may be surprised by the number of agreements that are involved in the closing. Depending on your particular transaction, your mergers and acquisitions attorneys may prepare a guarantee, a loan agreement, a non-competition agreement, a bill of sale, an assignment and assumption agreement, deeds of trust, trust deed note, consulting or employment agreements, articles of amendment to change the name of the business, asset acquisition statement, IRS Form 8594 and other agreements.
The major event at the closing of any business is the confirmation that the money has arrived. After the closing the buyer and seller usually agree to make final adjustments to the purchase price for stale inventory or prorated expenses and other things spelled out in the purchase and sale agreement.
Then the sale is complete and the glory of being a small business owner passes to the new owner.